What comes after MarketPlace Lending?

quotation-wayne-gretzky-i-skate-to-where-the-puck-is-going-to-be-11-73-11

Now that Lending Club is past its crisis mode and is just another mature company that has to impress investors with predictable growth in financials on a quarterly basis, we look at where the puck is headed in Lending.

What innovation will change the Lending game and create companies as big as Lending Club ten years from now?

Disclosure: I sold shares in Lending Club just before their recent quarterly earnings (Q4), having been fortunate enough to buy in at 3.51 after writing this post. Although I expect Lending Club to do well, the shares no longer have the great margin of safety that they did right after the crisis in May.

This post looks at four innovations that focus on two big imperatives facing any Lending entrepreneur – reducing Customer Acquisition Cost (where Customer = Borrower) and reducing Cost Of Capital (reducing the intermediary cost):

  • The next generation Deposit Account
  • Just in time Borrowing by consumers
  • Big Data for the lending to Micro Entrepreneurs
  • Automated working capital financing for SME

The next generation Deposit Account.

One big reason Banks have a low cost of capital is that consumers are willing to put up with lousy interest rates in order to get safety i.e. to know that their money is not at risk. The next generation Deposit Account could change that and our thesis is that the next generation Deposit Account will be based on the Lending Account.

Market Place Lending has created the first real banking innovation in hundreds of years which is the Lending Account. Until the likes of Prosper, Lending Club, Funding Circle and Lufax came along, consumers could have a Deposit Account (lend money to a bank) and a Loan Account (borrow money from a Bank) but could not directly lend in any simple scalable way.

This post shows how one Consumer has used Lending Accounts to make good money, much better than Lending to a Bank via a Deposit Account.

Most people don’t want to a) work that hard b) take that much risk. This is where the next generation Deposit Account is awaiting a great entrepreneur. The next generation Deposit Account will be a Lending Account that is ultra low risk and short tenor. Let’s start with tenor. If you are willing to lock up your capital for a few years, you can use existing Market Place Lending accounts. Compare the risk-adjusted return over 3 years compared to locking up your money in a 3 year Deposit account or a AAA Sovereign Bond and the Market Place Lending account looks pretty good.

However, most people want to have cash available at short notice for emergencies. They might want the notice/tenor to be weeks or at most months. That is hard to do using Market Place Lending accounts because the Borrower needs longer to repay. Unless you work hard to resell on a Secondary Market such as Foliofn, this is not an option.

This requires some financial engineering – the sort of thing that Wall Street has always done well. Through a mix of securitization, secondary markets and a cap & floor based guaranty, this is feasible. The arbitrage between lending to bank (Deposit account) and lending directly is big enough to give any entrepreneur enough to play with.

A note on securitization. Although securitization is seen as the villain of the Great Financial Crisis of 2008, there is nothing wrong with securitization per se. The issue is transparency. If you can hide a bunch of dodgy BBB loans in a shiny AAA package that is bad. If BBB loans are sold to those who know how to manage the risk/reward trade off, then markets are working as they should.

In addition to financial engineering, some UX magic is needed to make this as  simple for consumers as opening a Deposit Account.

If anybody is working on this, please let us know in comments.

Just in time Borrowing by consumers

The way a Market Place Lender like Lending Club or Prosper finds borrowers is remarkably old-fashioned. There is a lot of direct mail and search engine marketing to find consumers who want to refinance expensive credit card debt.

What if you eliminated the credit card phase and the Market Place Lender could acquire customers at the point of sale? That is what Klarna is doing for example; the proposition is bill me and I promise to pay. That can work in small, homogenous and relatively wealthy countries (eg Nordics, Switzerland) where the default rates will be relatively low.

This can also work at the opposite end of the spectrum in huge and relatively poor countries (such as China, India, Africa) where Credit Card penetration is low ie new models can appear at the point of sale to deliver lower cost borrowing to consumers at the point of purchase.

What is unclear is whether these new borrower acquisition models at the point of purchase will be part of a Lending Marketplace or part of an ecosystem that delivers customers to the Lending Marketplaces.

Big Data for the lending to Micro Entrepreneurs

You can lend to business or consumer or to the grey area in between of the self-employed “micro entrepreneur” where companies like Iwoca operate. The key here is that the revenue sources for these self-employed micro entrepreneurs are data rich services such as Uber, AirBnB, Amazon, Alibaba, eBay etc and data is the key to assessing lending risk.

Automated working capital financing for SME

Approved Payables Finance when the SME sells to Global 2000 type Corporates is working well. The APR is far lower than the SME would get from traditional finance or AltFi and Lenders get short tenor, self-liquidating high grade debt at far better interest rates than Sovereign Bond lending.

To date this has remained a niche play, despite working so well. This will scale when two things happen:

– An open standard drives e-invoicing to 90% plus adoption (the remaining 10% can be forced, enabing huge cuts in AR and AP processes). Once AR and AP is entirely digital, inserting just in time working capital financing options is easy.

– A credit rating for SME; today this only works when buyer is “investment grade”i.e. a corporate with a credit rating from an agency such as Moody’s, S&P or Fitch . If a butcher selling to a baker or candlestick maker could evaluate the credit rating of the  baker or candlestick maker, pricing credit would be simple and thus the APR would come down a lot. This is not rocket science and as always it is a data problem. All you need to know is does the baker or candlestick maker pay their bills on time.

———————————-

If anybody is working on solutions for the kind of innovation profiled here that we have not already mentioned, please tell us in comments.

Image Source

If you want to see these insights before your competitors, join over 16,600 of your global peers who subscribe by email and see these trends reported every day. Its free and all we need is your email.

 

With Lufax, Marketplace Lending is becoming a 4 horse global race

 

2020-chinese-consumer

On Monday we profiled Ping An Insurance, China’s largest insurer by market value. 

Yesterday we looked at Zhong An, which has Ping An as one its major (12%) shareholders.

Today we look at Lufax, which is 49% owned by Ping An. Lufax is a P2P Lending Marketplace, matching borrowers with investors for a 4% fee, but they have recently branched out into other asset classes such as equities.

Lufax (whose official name is Shanghai Lujiazui International Financial Asset Exchange Co.) was founded in 2011 and raised 3 billion yuan ($483 million) from international investors in 2015.

China Marketplace Lending Consolidation

The Lufax CEO, an American born McKinsey alum called Greg Gibb, was vocal about the coming consolidation in Marketplace Lending in China in a 2015 article in Bloomberg.

“The vast majority of China’s more than 1,500 peer-to-peer lenders are going to fail, with as few as one in 20 surviving.”

In our Oct 2016 report on Marketplace Lending in China, Lufax ranked no 2 on both transaction volume and number of borrowers. They are clearly well positioned for the consolidation.

Greg Gibb of Lufax was eloquent about the small players disappearing;

“Their business models are turning into pyramid schemes. Some promise unrealistic returns to investors and lend without enough data to determine borrowers’ creditworthiness”.

We looked at these issues in more depth in this post.

The Cambrian explosion of Marketplace Lending helped the market expand. As per Bloomberg, from original research by Yingcan Group, Marketplace Lending grew almost 13-fold since 2012 to $41 billion in 2015 and grew more than six times faster than loans extended through banks.

Global 4 Horse Race

P2P Lending originated in the UK but took off in the USA. For a long time we talked about a two horse race in the USA, with Lending Club and Prosper, although there are other big players in the USA with slightly different models such as SOFI and Avant. With their recent $100m raise and already active in both UK and USA, Funding Circle joins this small global group. We profiled them in this Oct 2015 post.

Our thesis is that the globalization of Marketplace Lending will play out inexorably but in fits and starts, deeply impacted by regulation and politics. There are three  drivers:

  • Best practices and technology adoption. As Lufax’s Gibb put it “how do you create transparency and the right asset-scoring process?” The US and UK are mature consumer lending marketplaces, but the growth is in places like China, India, Africa and South America. The company that manages to bring global best practices and technology to these big growth markets will be a very big winner.
  • Marketplaces expanding globally. So far the US firms have stayed in the US market. It is a big enough market and the problems in 2016 constrained any more ambitious plays. Funding Circle is different. They operate in a small domestic market, so like other ambitious UK firms, they went global early. How the Chinese firms play in this game will be key as they have both a big domestic market and big ambitions. We expect 2017 to be big on the M&A front.
  • Lenders looking for global diversification. Most lenders have never had this opportunity before. Only big global banks could compare the risk/reward arbitrage across countries. Now any Hedge Fund can play and so even can Mrs. Watanabe and her global peer Joe Q Public. Entrepreneurs who make this easy by enabling global diversification will win. They may be acquired by the Marketplace Lending platforms or stay independent as a layer in the value ecosystem.

Lufax expanding into Equities

This article in South China Morning Post describes how Lufax is now also creating an international equity trading platform.

This goes against the grain of the Silicon Valley innovation model which is clearly focus, focus, focus. This is an example of how China is different. People used to the Silicon Valley innovation model assume that Lufax is doing rash  diversification by moving from Fixed Income into Equities. The mantra is that Consumer Lending is massive and complex, so “stick to your knitting”. That makes sense if it is a small founding team using step ladder VC funding. It is different when a firm is created by one or more big established firms, so that financial, human and other resources are not a constraint. It is also different in a fast growing market where consumer trust is critical and with many spaces where no incumbent yet has that trust. One of our mantras is that “bits don’t stop at category borders”, that digitization breaks down previously distinct categories if the user need is there. There is a real user need, for multi-asset strategies (such as some Fixed Income and some Equities).

Lufax is positioning to serve Chinese investors’ asset allocation around the globe. In 2007, China ruled that each mainlander is allowed to buy up to US$50,000 worth of foreign currencies a year. This gives Chinese people a legal channel through which to diversify their assets.

Lufax plans to offer an online wealth platform in 2017 to serve those needs. According to Lufax CEO, Greg Gibb:

“Demand for overseas investment among Chinese people and businesses is constantly increasing. Lufax hopes to leverage new technologies and models to provide clients internationalised services.”

Lufax has announced partnerships with two firms – eToro for  social trading and Denmark-based Saxo Bank.

Big bet on the Chinese consumer

The Chinese consumer demand for loans is high as the country transitions from being export led to becoming a consumer economy. This is leading to high growth with few big incumbents as competitors. Lending Club and Prosper have to compete with big, smart, agile banks in America. Imagine being able to bet on the American consumer 100 years ago, but with the Internet as a delivery tool.

Of course such opportunity does not come without risks such as lack of consumer finance models and a possibly overheated economy. Entrepreneurs look at these risks to guide their action plan.

Lufax has a clear bet on the Chinese consumer, both enabling them to borrow and to invest their excess capital.

However, the Chinese consumer is only one possibility in a global economy.

Along with Lending Club, Prosper and Funding Circle, Lufax is in a 4 horse race for the global consumer lending opportunity.

Image Source

If you want to see these insights before your competitors, join over 16,200 of your global peers who subscribe by email and see these trends reported every day. Its free and all we need is your email.

 

 

 

Back to the future of P2P Lending, we interview one of those peers

img_1088

The founding idea of both Lending Club and Prosper was Peer To Peer (P2P) Lending. Along the way, professional intermediaries aka Institutions got into the act and we started referring to Market Place Lending or Altfi. P2P Lending means no other intermediaries – just Lender + Borrower + Platform. The imperative to scale fast, to keep equity investors happy, forced the platforms to get capital from professional intermediaries. Something was lost in this transition. Professional intermediaries add fees and also tend to be less loyal as they see their job as moving money around fast to protect their investors. 

Hector Nunez is a good example of those original P2P retail investors. He has been investing in notes on Prosper since the early days. In an ironic twist that tells a lot about Fintech in the capital markets, Hector also has a job as a doorman at 75 Wall Street in New York City, which used to house trading rooms and now has been turned into apartments (in the new FiDi or Financial District of Manhattan). Hector was one of the early investors in Prosper loan notes and turned his $5k original stake into $138k over 10 years. This is a track record that most professionals would envy. See later for how this translates to IRR.

So it made sense to get Hector’s take on some of the big shifts in this market.

What is the difference between retail and institutional investors?

Our thesis is that three things separate the retail investor from the institutional/professional investor:

  1. Access to tools, techniques and data. Fintech is democratizing the tools, techniques and data that used to only be available to professional intermediaries. This is a work in process. Some tools are still only available to professional intermediaries, simply due to how they are priced, but this will change as new players come into the market. Techniques can come from books, blogs, forums and online courses. Platforms give access to data to encourage investors. So it is only tools that are lacking and entrepreneurs who build these tools know that this is primarily a pricing decision and that selling to 100 retail investors at 1c is the same as selling to one Institution for $1 and may be easier. We asked Hector about some of these tools.
  1. OPM (Other People’s Money). Institutions invest OPM. Retail investors invest their own money. To invest well you have to be a) contrarian and b) right. It is hard to be contrarian when you invest OPM – you have explanation risk. Retail investors have no explanation risk. When they are contrarian and wrong, they only have to explain it to the mirror and learn from why they lost.
  1. Concentration. One Institution can lend a lot of money and that is a quicker way to scale a platform than persuading lots of retail investors to use the platform. One retail investor might be able to deploy $300k while an Institution can easily do 100x that i.e $30m (but that $30m can also disappear equally fast as Institutions tend to be more trigger-happy). Getting 100 retail investors to deploy $300k or 1,000 to deploy $30k certainly takes longer, but it gives the platforms more long-term capital. One way to think about the retail investor is like a bank depositor who takes more risk and does more work for a much higher return.

Hector explains how he invests

I asked Hector to explain his investing approach:

Prosper gives borrowers credit grades (“AA,” “A,” “B,” “C,” “D,” “E” and “HR”) in which the investor sees and gets to invest in the loan the way she/he sees fit. In my case, I’m investing in only 2 grades (“B” and “E”). I have other grades but those are the ones that are in beta mode or that I ceased to invest in. Because there are only 3 or 5 years terms, it takes that long to purge the grades that I’m no longer interested in investing. Now one can argue that this is the disadvantage in retail P2P lending in that once something goes wrong, there’s no essential bail out. I would argue that this is actually beneficial because it teaches me to stay away from certain kind of loans with certain kind of attributes. As opposed to “jumping ship” early and probably not learning exactly why the loan went south. So I set a fixed amount of notes in 3 credit grades that I’m going to invest in and that number is 200. diversification is key and that by having 100 loans (notes), the investor is almost guaranteed to have a gain.

Agile Investing and IRR

Institutional/professional investors focus on IRR (Internal Rate of Return). It is a metric that shows performance. Hector, like most retail investors, does not obsess about IRR because he is not selling to investors.

What Hector is doing – and other retail investors work in a similar way – is what I call agile investing. Like agile programming, you start small and add more and refine the approach as you get market feedback (what you win and what you lose).

In Hector’s words:

Here’s what I started with: 5K which 10 years later (this upcoming March) is currently @ ~$138K. Please note that this includes both my trial and error loans as well as my lower interest loans. I started with 5K, then I put in an additional 10K, then 15K, another 30K and then another $20K. Throughout this process I’ve taken out then put some funds back in so overall, my principle is ~$80K and the rest is in excess of principle.

If Hector was running a Fund and pitching OPM for money, he would track all of those inputs and outputs to calculate IRR. That is how intermediaries work and IRR is a useful tool. However, what Hector is describing is how individual investors work which is to experiment and put more into what works. This is what I call “agile investing”. Note that “individual investors” could mean people with a lot of money to invest – think of Family Offices and Prop Traders.  So this maybe the new mode of investing that the micro asset managers use (see later for follow/copy/mirror model investing).

Ceiling?

I asked Hector what kind of “ceiling” he sees for this way of investing.

I cap off 200 loans for each grade that I’m investing, because I believe there is a point where too much diversity negates gains and losses. Also, years ago, Prosper imposed a percentage limit on both retail and institutional investors which affects the monetary amount that I could invest in. Currently it is @ 10% for the 1st 24 hours. In other words, when a borrower posts his/her loan on Prosper, any investor could only contribute (invest) to 10% of the borrower’s total loan within the 1st 24 hours of the borrower’s loan. After that, the cap is lifted and the investor could invest any monetary amount. I only invest to the 10% limit so monetary wise I’m also capped. So my overall monetary ceiling is currently @ ~$400K and my overall note ceiling is currently @ a little over 500 which includes my beta loans. Once, I reach those goals, I will then have to branch out into other platforms i.e Folio and apply my tried tested and proven strategy on that platform.

Hold to maturity or trade on secondary market?

Prosper announced in September 2016 that they were Closing Down Their Secondary Market for Retail Investors. Prosper had been running a secondary market via FOLIOfn since 2009.

This is the sort of tool that Institutions have taken for granted for a long time.

The old fashioned idea of a bond was to hold it to maturity, collecting interest along the way and many Institutions still like to work this way.

I asked Hector for his take on this:

“Personally I’m not affected by this move as I never had plans on selling my notes on Folio. Remember, we had Folio as an option to sell and I knew it and I never bothered to look at Folio to sell my notes. And in that aspect, I believe I was a typical investor and part of the reason why I think Prosper and Folio parted ways. Remember, if loans default, there’s still a chance we can recoup our losses via the collection agency which work on our behalf (as opposed to losses in the stock where there is no chance of recouping). With Prosper there’s a chance that the collection agency can recoup some if not all your principal with the interest (all for a small fee of course which the agency automatically takes from the funds recovered). I did create a Folio account but that was as a security blanket which I would have put in use had the majority of my investment soured. As the story went, it never did.”

Cross platform investing

Institutional investors are strong on diversification. Hector agrees, but has a slightly different take:

“I believe in that old cliche that you should not put too many eggs in one basket. I am all about cross platform investing. Should one platform go south, you have another to pick you right up; however I only believe that to a point. My belief is that too many investments would cancel themselves out leaving the investor with little financial movement either way (gain or loss).”

Hector is referring is what Institutional Investors call “closet indexing”, when investors diversify so much that the end result is very close to an index (which you can buy for very little from somebody like Vanguard).

One way to diversify is to go global. I asked Hector whether he would consider investing outside America, via platforms in those countries. Hector was clear on this front and his logic was interesting:

No and as of now I don’t have any plans on doing so. There are a couple of reasons why. First, I must complete my investment goal on Prosper before I step on to a new Market. I will make an exception with Folio because I already have an account and I’ve been doing my research with them for quite some time. Second, I trust the American market more than international markets because I feel that I have a better pulse on the US market than that of another country. Probably this is because I live in the US. My strategy relies much on understanding their personal financial background in the context of some event that makes them need a loan. Example: A person could be asking for a loan because he/she may have psychological issues and need their medical expenses paid off and the borrower has a pretty decent financial history while another person may be asking for a loan for a vacation and have a questionable financial history. I would lend to the person in medical need not because of what the borrower is going to use my funds for but rather because of their proven financial track history.

Hector ends with what all good investors have – humility and a learn it all attitude rather than a know it all attitude:

Believe it or not I’m still learning on Prosper and still letting my “beta” notes play.

Can I follow/copy/mirror Hector?

One theme that we have been exploring on Daily Fintech is the emergence of Micro Asset Managers enabled by the follow/copy/mirror model:

  • Copy and mirror trading platforms like eToro, Zulu Trade, Darwinex.
  • Thematic investing marketplaces that allow new micro-managers to emerge by creating their own financial product (equity based), and actively manage it; like Motif Investing, and Wikifolios.
  • Even social research platforms like StockTwits are stepping into this space by offering Follow functions and rankings of the subscriber micro-managers.

This is an alternative to either passive low cost index tracking or high cost active hedge funds. The idea is simply to follow/copy/mirror an investor who is investing their own money. This allows a passive investor (who does not want to work hard at the investing game) to follow/copy/mirror the active investor (somebody like Hector) who gets some share of the upside. That active investor does not need to gather or manage investor’s assets, so they do not need to charge an AUM fee. This is a game-changer in the massive asset management business.

Hector was eloquent that IRR % was more important than total funds under management:

I believe that the amount of money one has in investment is not the sign or bar of performance rather it is the rate of return. A person can have a million dollars in stocks and come out at years end with 1.1 million and another investor could have 100K and turn a profit of $20k and it is the latter investor that I would be most impressed with and try to emulate.

The follow/copy/mirror model is working today in VC (Angel List) and in Public Equities and in FX, but I am not aware of anybody doing it in Fixed Income/Lending. Hector is the sort of investor I would like to follow/copy/mirror. I asked Hector for his take on this:

I welcome you and any potential retail Prosper investor to follow my lead. I could give you or anyone nice fundamental tips in getting started as well as giving you warnings and recommendations. If you or anyone wishes to get started, please let me know.

It will be interesting to see if the Lending platforms start to offer this or if some other platform specific to the follow/copy/mirror model offer a cross-platform capability.

If you want to see these insights before your competitors, join over 15,600 of your global peers who subscribe by email and see these trends reported every day. Its free and all we need is your email.

 

 

What does the Credify story tell us about Market Place Lending and $LC stock?

clark-reading-the-daily-planet

This story broke on Wednesday 15 November. 

The story is that the founder of Lending Club, Renaud Leplanche, who was ousted in a scandal in May was creating a new venture to compete with Lending Club called Credify. Headlines talked about 2nd Act or Comeback.

The story came out in the Wall Street Journal (WSJ)  and appeared to be good old-fashioned journalism – digging around for a scoop by looking at corporate filings.

I do not think there is much of a story about Credify itself. The chances of success for that venture are slim (more on that later). The story hangs on 3 threads:

– What does this tell us about the state of online journalism?

– Does this justify selling Lending Club stock?

– What does this story tell us about the transformation of consumer lending

What does this tell us about the state of online journalism?

News drives markets and digitization is changing news, so this is indirectly a Fintech story.

As a media entrepreneur this aspect of the story interests me.

This was either a non-story done under time pressure that had a big impact or an old-fashioned scoop from hard core investigative journalism. The latter is to be celebrated because the economics of digital media don’t allow much budget for hard core investigative journalism. Imagine All The Presidents Men today.

The time pressure on journalists today is intense, because the online ad model post search, social and adblockers, does not allow time for hard core investigative journalism.

There is no site for Credify (various spellings and .tld urls end up in a blind alley) and nobody is talking on the record. Let’s assume the story is true. It certainly appears that a company called Credify was created by Renaud Leplanche. Without a famous name impacting a public stock, this event would have gone unnoticed – just one out of 1,000,000 new businesses created each year in America alone.

So I incline to this being a non-story done under time pressure. Of course, only time will tell and events may prove me wrong. Credify may launch and quickly get to the $50m in revenues mentioned in the WSJ article as the target for 2017.

A non-story done under time pressure unsettles markets because, if it comes from an authoritative source such as WSJ, other publications repeat the story citing the original post as evidence. That is what happened in the Credify story, which was briefly on the technology front page (Techmeme).

Does this justify selling Lending Club stock?

No.

$LC stock did decline a bit the day after on the 16th and by more than 5% a day later on the 17th and a bit more on the 18th. Over $125m of market value evaporated. Nobody knows for sure why a stock moves – in this case there were also options expiring, the stock had gone up sharply and may have needed a correction, there was a negative post on Zero Hedge (do they have positive posts?) and a story about Lending Tree that defined them as competitors (incorrectly in my view).

Disclosure; I bought LC stock after the May crash (got in at 3.51). That is why I was paying attention to the Credify story. My investing approach is to do a lot of fundamental analysis before buying so that I have context to look at news as it comes in and make a Buy/Sell/Hold decision. This story was a Hold decision – it was “noise on the line”.

Reactions of retail traders on stock forums mostly also did not think that the story was significant. This was a sample reaction:

“Not sure why Laplanche startup would be more concerning than Goldman’s market entry.”

Which brings us to the final part of this story.

What does this story tell us about the transformation of consumer lending?

Lending Club is the bellwether of MarketPlace Lending. It may well be bellwether of the whole Fintech market. If Lending Club fails, investors will tell Fintech entrepreneurs “stop trying to compete with banks, go back to the old model of selling software to banks”.

I am calling this market the transformation of consumer lending, because so many of the names don’t quite fit any more:

– P2P Lending. This is what it was called when early visionaries such as Renaud Leplanche were getting started about 7 years ago. Individual lends to individual via the platform – beautifully simple and revolutionary concept. Whatever else Renaud Leplanche does with his life, the world owes him a debt of gratitude for making that work.

– Market Place Lending. This name evolved when fast moving credit hedge funds and other institutional lenders in moved in. Now the value chain got longer. Individual lends to Institution which lends to individual via the platform.

– AltFi. In this iteration, the market place disappears. The credit hedge fund buys or builds the digital loan origination technology so that they can lend directly to individuals from their own balance sheet. This is also sometimes called balance sheet market place lenders. There are also hybrid models with some balance sheet lending and some market place lending.  Examples include Avant and SOFI.

– Digital Lending. In this iteration, the credit hedge fund disappears. Banks buy or build the digital loan origination technology so that they can lend directly to individuals from their own balance sheet. As Banks have a lower cost of capital they can beat the credit hedge fund. First out of the gate is Goldman Sachs with Marcus. They will beat the AltFi Lenders because of lower cost of capital.

Consumer Lending is such a massive market and we are still in the early days, but it is an utterly different market from when Renaud Leplanche was doing his pioneering work in the founding days of Lending Club.

One thing that gives me confidence in Lending Club (and Prosper but they are still private so I cannot buy their stock) is that the original P2P Lenders are still there. They may only be one lender, along with Banks and other Institutions, but they are still there. The humble retail lender has confidence because they get good risk adjusted returns compared to any other credit avenue (if they are careful). That confidence gives me confidence as an equity investor.

There is some news that would prompt me to sell LC stock. If the new CEO was also caught doing something wrong my take would be “once means nothing, twice is coincidence and three times is a trend and I am not waiting around for the third time”. The Lending Club Board proved in May that they are vigilant and decisive, so I think this is unlikely.

Fintech is fundamentally about the democratization of technology. Given the right tools, smarts and hard work, a retail lender can do what a credit hedge fund does. There has never been a shortage of people with smarts and hard work. Now they are also getting the tools. That is the revolutionary promise of Fintech in a nutshell.

Given that analysis, what would a smart entrepreneur who knows consumer lending do today:

– P2P Lending. Building consumer trust and network effects is a long game and the consumer lending market is no longer in the nascent phase that rewards a long game.

– Market Place Lending. Building Institutional trust takes time. The May scandal that led to Laplanche being fired broke that trust. This would be a hard sell.

– AltFi. This was a good play a few years ago, but with Banks like Goldmans getting into the game, this would be highly risky today.

– Digital Lending. Only an option if you are a licensed deposit taking bank.

That analysis told me that it was not time to sell LC stock and that the next iteration of this market is back to the original P2P Lending model of empowering retail lenders on a mass scale.

Image source

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Market Place Lending is simply automated Asset Liability Management and that is a big deal. 

alm_cabinelr

Image source

Eons ago I managed a sales team that sold core banking systems to global banks. One sales guy was consistently the best performer. I decided to find out his secret to teach it to the rest of the sales team. 

He had found a report that senior managers really wanted and that was easy to create in our system and that was hard to create for our competitors. He had senior management attention and a moat against competition – simple and brilliant.

The report related to Asset Liability Management. So I took a crash course to understand the rather dry subject of Asset Liability Management (ALM). Despite being a dry (read boring) subject, it is key to banking. In short, a bank with good ALM has very low risk and makes good profit and vice versa. 

Asset Liability Management 101

ALM is simply matching the Bank’s Deposits (aka what a bank borrowers from Consumers aka a Liability as seen on the Bank’s balance sheet) with with their Loans (aka what a Bank Lends to a consumer or other entity aka an Asset as seen on the Bank’s balance sheet). If Assets and Liabilities get out of alignment, the Bank has high risk. For example if a Bank gets Deposits on a 3 Month Term and Lends them on a 3 Year Term, something could go badly wrong. 

Of course, if Banks can borrow on a 3 Month Term and Lend on a 3 Year Term, everything is peachy until too many Consumers ask for their money back at the same time. When that happens it is called a “run on the bank” or systemic risk; Governments and their taxpayers are signaling that they don’t like spending taxpayers money to bail out banks when that happens.

A bank with good ALM poses no systemic risk. 

Which brings us to Market Place Lending. People have pointed out that Market Place Lenders don’t pose systemic risk. If a borrower has a 3 year term then the Lender has to have a 3 year term; they have to match or the transaction does not close.

Market Place Lending has perfect ALM.

When you look at Market Place Lending in those terms you can see how powerful it is. In the original P2P Lending model Consumer A Borrows and Consumer B Lends. The marketplace simply matches them. There cannot be any ALM mismatch. If the Borrower wants a 3 Year Term, the Lender has to accept a 3 Year Term or decline the transaction. 

As the Market Place Lending market grew, intermediaries such as Banks and Hedge Funds jumped into the Transaction. Now the value chain is Consumer A Lends to a Bank or Hedge Fund who then lends to Consumer B. Of course in our complex Financial System that chain can be longer – Consumer A Lends to Insurance or Pension Fund who lends to Bank or Hedge Fund who then lends to Consumer B. However, as long and complex as that value chain gets, it is still Consumer A lending to Consumer B.

The problem for all the intermediaries in that value chain is when Consumer A and Consumer B figure that out at scale. 

“My excess cash flow goes straight to my deposit account”

That is an actual comment from a Pensioner who is living well within his means. He has an old fashioned Defined Benefits Pension that is inflation adjusted. He earns more than he needs to spend.  

 This is enabled by a  Sweep Account – well known to anybody who uses Banks prudently. That Pensioner has his bank automatically transfer money from his “Current Account” to his Deposit Account. (The Pensioner was British, if he was American he would have referred to his “Checking Account”). He knew he was getting a lousy deal on that Deposit Account, but did not fancy the hard work of figuring out how to make good risk adjusted loans via a Market Place Lending platform.

Post PSD2, a Fintech startup could sweep that into a Lending Account based on risk/return profile. That is is the sort of “take something complex and make it easy and intuitive with some UX magic” that digital startups excel at. The prize is big. It could be one of the Deposit Innovators that we profiled back in July who seizes this prize. Or an existing Market Place Lender. This is still a nascent wide open opportunity.

Sweep Accounts into Market Place Lending could eliminate the cost of funds advantage that banks have today and that is a really big deal.

To see the real spread enjoyed by Banks, look at this analysis on Nerd Wallet of the best term deposit rates and then contrast that with the Average Net Annualized Returns on Lending Club.

Dear Mr Treasurer, how much do you love your ZIRP and NIRP?

The first to break the dam might be Corporate Treasurers. Like the Pensioner, they know that they are getting a lousy deal on Bank Deposits. Unlike the Pensioner, they have the resources to do something about it. Corporate Treasurers are already doing something about it by lending to their vendors through Supply Chain Finance (SCF). When SCF connects with MPL, the change will come very fast.

Today Corporate Treasurers use sweep accounts to get excess cash into Money Market investments, such as repurchase agreements or commercial paper. SCF is another short-duration investment. However Corporates have excess cash that they don’t need for longer durations so could easily Lend to Consumers or Small Biz for a 1,2, or 3 year terms. 

That is why we believe that Market Place Lending is still in its infancy and will fundamentally change the world and why Lending Club could the Priceline of Fintech. (Disclosure I was fortunate enough to buy Lending Club stock at 3.51).

 Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Which Chinese Market Place Lenders will emerge from consolidation?

industry-consolidation-graphic.png

Image source

This is part 2 of our research into Chinese Market Place Lenders. Part 1 is here.

Ppdai is credited with being the first MPL (then called P2P Lending) in China, following close behind pioneers in UK and USA. Since then, literally thousands of platforms emerged. This is clearly unsustainable. Market Place Lending is a networks effects business. More borrowers lead to more lenders and vice versa. So the thousands of MPL platforms in China has to come down to a handful of companies.

Top of the Pops

The top 20 platforms as tracked by Wangdaizhijia and reported by Lendit are:

1 Hongling Capital
2 Lufax
3 PPmoney
4 Wzdai
5 Weidai
6 Xinhehui
7 Yooli
8 Jimubox
9 Jinxin99
10 Renrendai
11 Srong
12 Yirendai
13 Xiangshang360
14 Edai
15 Niwodai
16 Touna.cn
17 Eloancn
18 Qianbaba
19 Itouzi
20 Tuandai

Source: Wangdaizhijia

The only names that resonate in the West are Yirendai (because they did an IPO in America) and Lufax (because they are publicly mulling an IPO in Hong Kong). Lufax is being valued almost 10x Yirendai and ranks second place vs 12th for Yirendai. So Yirendau could be like Ondeck vs Lending Club, first out of the IPO gate but small compared the market leader and it may be acquisition bait during the consolidation phase.

The IPO process for Lufax may bring a) capital b) more mature processes (due to public scrutiny) and c) consumer name recognition. For the latter, the Hong Kong venue for Lufax makes the most sense.

Here are the top 3 ranked by Transaction Volume:

Company Transaction Vol No. of borrowers  
 
Hongling Capital 300,401 3,944  
 
Lufax 137,250 24,984  
 
PPmoney 130,909 5,506  
 

Here are the top 3 ranked by No of Borrowers:

Company Transaction Vol No. of borrowers  
 
Xiangshang360 46,872 30,497  
 
Luffa 137,250 24,984  
 
Weidai 83,250 11,550  
 

(Yirendai is 4th).

Note LUFAX in second place on both scores. If their IPO in Hong Kong goes well, they look like a strong contender.

What role will BAT (Baidu Alibaba TenCent) play?

These are behemoths by any definition. In simple market cap terms (rounded to nearest $ billion as of Oct 2016):

Baidu = 61

Alibaba = 263

TenCent = 258

In comparison Lending Club = 2 and Lufax (pending IPO) = 18.

How much these giants want to get into Lending is the key question. All three have launched online banks, with Baidu the most recent into the game.

So, we can expect plenty of excitement as the MPL market in China matures.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

The big and scary prize – Marketplace Lending in China

mqdefault

Image source

This is a two part investigation. Part two will be on Friday.

Big: a big and fast growing middle class and a banking sector that has been asleep at the switch on the consumer side; the idea of China as a consumer market is relatively new and Chinese banks are not known for being agile. Imagine the American market without Wells Fargo, JP Morgan Chase and Citi as competitors. According to Citi, 96% of e-commerce sales in China are done without a bank’s involvement.

Scary: just ask Travis Kalanick of Uber; the most full-steam ahead damn the torpedoes entrepreneur was beaten by Didi in China. His retreat will probably be a hugely profitable deal (like Yahoo and Alibaba) but it is still a retreat. It is really tough to compete in China. So, scary for Western firms. For Chinese firms, scary if you have to compete with BAT (Baidu Alibaba Tencent).

To understand where this puck is headed, we seek answers to the following 5 questions:

Will China MPL follow the Uber Didi trajectory?

How will global lenders get in on the action?

How is the progress from Wild West to Settler phase?

In Part 2:

Which Chinese Marketplace Lenders will emerge from consolidation?

What role will BAT (Baidu Alibaba TenCent) play?

Will China MPL follow the Uber Didi trajectory?

Trajectory: big Western firm spends a lot of money to get into the market and eventually cedes victory to a Chinese competitor and before retreating gets a big shareholding in the competitor that beat them.

You could argue either case:

Yes: look at the tribulations of other Western Internet firms in China. Google lost as did Facebook and Uber.

No: China has a lot at stake. If they have to trade off lower interest rates for consumers (benefitting hundreds of millions of Chinese) vs protecting a local firm, it will be a tough decision. Also, it is unclear why Didi beat Uber. Was this a level playing field where “the best man won” like on an English boarding school rugby pitch? Or was the referee biased to the local team? Baidu almost certainly won because the Chinese government wanted a search firm that was friendly to their interests. It is not clear if that is why Tencent won in messaging or why Didi won in car sharing. If it is a level playing field, a great Western entrepreneur can hire a great Chinese team to localise properly and can still win.

Western MPL has not yet made a serious crack at the China market; if you never attack you don’t need to retreat. It is hard to imagine the shareholders of Lending Club or Prosper backing a super expensive high risk entry into China – not after Uber got their head handed to them.

So, China MPL will NOT follow the Uber Didi trajectory, because that story will prevent any Western MPL from trying. The Uber Didi story has entrenched the view that you cannot win in China.

How will global lenders get in on the action?

China has a very high savings rate (30%), so local banks should have plenty of cash but most do not have the systems and processes to do consumer lending profitably at scale. So there is a window of opportunity for global lenders to get in on the action. They will do so when the Sherriff cleans out the bandits (see next section).

As the MPL market matures globally, we expect to see more platforms that allow a retail lender anywhere to choose which geographic market they want to lend into; for example, when a Chinese consumer can lend to a Swiss consumer and vice versa, MPL will have gone global and mainstream.

For example, Mintos connects investors with non-bank lenders from mutliple European countries.

Many consumer lenders tend to stick to their local market; over time we expect more will go where the risk adjusted returns are best – even if it looks “foreign” at first. For example, lending money at 26% on the P2P Lithuanian platform that shows us 4% default rates may look too exotic, but some savvy investors have already found this to be attractive.

We expect to see more of this cross border lending because MPL platform are competing with each other, margins narrowing and one avenue of growth will be by moving into other countries. There are still a lot of tax related issues that are unclear.

Most unclear is whether China will welcome cross border lending. This news about Yirendai’s parent Credit Ease investing in Prosper and Avant loans indicates financing flowing one way.

How is the progress from Wild West to Settler phase?

MPL in China is in the Wild West phase, with hundreds of marketplaces and lots of scams and very crude, violent debt collection practices. We know how this movie ends – the Sherriff rounds up the bad guys and the settlers move in and we get towns and cities and the big money is made.

Some progress is being made, some of it from the free market and some of it from the government.

“For thousands of years, debt collection in China has been a mafia business,” said Wen Yong, chief executive of Shenzhen-based ZZG360 (ZZG stands for Zhai Zong Guan which translates to “debt explorer”. ZZG360 list problem loans on MPL platforms and provide that data to debt collectors, which must agree to use legal, non-violent methods when recovering it.

The Government Regulators are also stepping up to the plate; the Sherriff has posted the new rules. Crowdfund Insider has a good report on the 12 commandments laid down in December 2015 by the China Banking Regulatory Commission (“CBRC”). Thou shalt not (my comments in italics):

  1. Use the platform for self-financing or for financing of related parties. (This stops the most egregious scams).
  2. Directly or indirectly accept and manage lender funds. (This is interesting. It prevents what in the West has become called Balance Sheet Alt Fi Lenders and it is unclear if that is a bad thing).
  3. Provide guarantees to lenders or promise guaranteed returns on principal and interest.
  4. Market or recommend loan investments to users that have not completed identification verification after registering on the platform
  5. Directly make loans to borrowers, unless stated otherwise by applicable laws and regulations
  6. Structure loans into investment products with liquidity timing that differs from the original loan term (“thou shalt not have have Asset Liability Mismatch” is another way of saying “thou shalt not have systemic risk”).
  7. Sell bank wealth management products, mutual funds, insurance annuities and other financial products (Hmm, so MPL can only be an exchange, China is banning the 20th century strategy of vertical integration).
  8. Unless stated otherwise by applicable laws and regulations, collaborate with other investment or brokerage businesses to bundle, sell or broker investment products (sounds like the sort of grey area that would make fortunes for lawyers and/or those with good connections).
  9. Provide false loan information or create unrealistic return expectations.
  10. Facilitate loans for the purpose of making investments in the stock market. (No borrower would offer this as a reason to get a loan, so this sounds like the Casablanca scene “I am shocked. Shocked!! to find that there is gambling going on”).
  11. Provide equity crowdfunding or project crowdfunding platform services. (Separation of asset classes by statute sounds like a hindrance to innovation).
  12. Other activities forbidden by applicable laws and regulations (legal catch all phrase).

This is a market without FICO that may invent a better alternative to FICO. That seems to be what ZZG360 is aiming for. The company is growing fast – with around 59 debt collection agencies and Rmb1.3bn ($195m) in debt on its platform. Like FICO, ZZG360 does not buy or sell debt. So it is not regulated, but by shining a data light on an opaque business it is part of the move from wild west to settler phase.

This clean-up phase also involves trading bad debt via online platforms. Companies with too much debt can sell unpaid accounts receivables or assets held as collateral in order to clean up their balance sheet. The banks have an unsustainable level of Non Performing Loans (NPL is officially 1.75%, but some analysts put the real figure as high as 15%). Internet Finance (the Chinese name for Fintech) may sort out this problem before the banks do.

On Friday, our investigation turns to Which Chinese MPL platforms will emerge from consolidation. Sign up to get our daily research delivered by email so you don’t miss this (link on top right of this site).

 

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.